Financial Intermediation and Capital Reallocation

We develop a general equilibrium framework to quantify the importance of intermediated capital reallocation in affecting macroeconomic fluctuations and asset returns. In our model, financial intermediaries intermediate capital reallocation between low productivity firms with excess capital and high productivity firms who need credit. Because lending contracts cannot be perfectly enforced, capital misallocation lowers aggregate productivity when intermediaries are financially constrained. As a result, shocks originated from the financial sector manifest themselves as fluctuations in total factor productivity and account for most of the business cycle variations in macroeconomic quantities. Our model produces a pro-cyclical capital reallocation and is consistent with the stylized fact that the volatilities of productivity are counter-cyclical at both the firm and the aggregate level. On the asset pricing side, our model matches well moments of interest rate spreads in the data and successfully generates a high and counter-cyclical equity premium.